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Three ponders big squeeze: City, duopoly, Ofcom have little sympathy

And then there were ... 3

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UK punters face higher prices from an oligopoly of three mobile providers unless Ofcom rethinks its spectrum policy, Three UK's CEO Kevin Russell said at a policy debate in London today.

As it stands, Ofcom will hand all of the prime 900Mhz spectrum currently used by Vodafone and O2 for 2G back to them to use again for 3G. Ofcom had wanted to parcel it out – as other countries do, to make sure market competition remains keen. The decision to hand this public property back to Voda and O2 raises doubts about Three's continued participation in the UK market – which Russell did nothing to dispel.

Three's chief made a strong case for the benefits of competition, particularly in the form of lower prices. He pointed out that 18 new licences were created in Europe for 3G a decade ago – of which only seven survive. Six of those are Hutchison's 3. But in those markets where a newcomer has survived, voice calls are 19 per cent lower, and data prices 28 per cent lower.

"How much do you want to stick in our backs?" Russell asked. "At some point you will end up with three players in the marketplace and by the way, 18 months ago, you had five."

Russell said that 97 per cent of traffic on his network is now data – Three carries half of the UK's mobile data traffic and sells more iPhones than any other operator. At 900Mhz coverage is better; an operator without a lot of sites, and a lot of low frequency would struggle to be competitive.

No wonder Vodafone and Telefonica's O2 are lobbying so hard to starve Three of the 900Mhz real estate. The benefits in the long run of higher prices and higher margins are immense.

Other countries have parcelled up the lower frequencies to ensure the market doesn't get sewn up between a few players. 3G currently works at the 2100Mhz frequency, with the superior 900Mhz range used by O2 and Vodafone, and 1800Mhz by Everything Everywhere (Orange and T-Mobile) for 3G. Three holds no 2G spectrum. Spectrum has been refarmed in the Netherlands and Ireland for example, and reallocated in France, Germany and Italy. The UK is alone in handing the original frequencies back to the original two holders of GSM licences in the UK.

But is Three crying Chicken Little? Lee Sanders of consultancy and research company Analysys Mason didn't think so, and agreed with Russell's appraisal of the market.

"I'll be surprised if Three can carry this on forever given the growth in traffic and the spectrum it has," he said.

Without decent spectrum, said Sanders, Three would have to chose from a palette of unattractive options – such as choking demand with pricing, or charging different amounts for different products or services. This is an anathema to Three, which has popularised all-you-can-eat data.

Russell found little sympathy from either Ofcom or the City.

Barclays Capital analyst Jonathan Dann described Telefonica and Vodafone's strategy as trying to "create a drought in their neighbours' backyards".

In 2007 Ofcom favoured O2 and Vodafone keeping most of the 900Mhz, but an auction for the rest, so the duopoly could not enjoy an unfair advantage. After the Carter Report of 2009, Ofcom introduced the idea of "Adminstered Incentive Price" – effectively an annual licence fee for spectrum holders – and then dropped any mention of reallocation or refarming.

Ofcom did so on the basis of a cost-benefit analysis that suggest that an operator in the 2100Ghz range sites could be competitive with one in the 900Mhz range if it had three times as many sites. (PDF/670KB)

Ofcom's partner in charge of spectrum, Hyacinth Nwana, explained that other spectrum was coming up.

"We fully understand that Three doesn't agree. That advice was predicated on the forthcoming availability of 800Mhz and 2.6Ghz giving players who don't have frequency the ability to acquire the frequency."

Ofcom makes the odd justification that since T-Mobile and Three share sites and masts (but not spectrum), there is no need to give Three the chance to bid to operate in the 900Mhz range.

"Ofcom got that badly wrong," responded Russell. "If somebody's foot is on your head they don't let you get back up."

And the City view?

Fewer operators mean higher profits, of course. BarCap's Dann said he favoured fewer players in the market, as this meant greater returns for shareholders.

"The hope of the City is that all the smaller operators will sell out," he said. "The City wants in-market consolidation." So the die seems cast, there.

Nwana seemed much more excited by the prospect of more auctions than the fate of the 900Mhz band – he couldn't wait to move on to talk about the 700Mhz band used by TV. And the prospect of an annual licence fee from the industry. It reminded this reporter of Ofcom in its pomp, when it relished its role as a tax collector.

Regulators, eh? Sometimes they're captured by the biggest players – and sometimes they just capture themselves. ®

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